Friday, March 19, 2010

Where Do Pensions Stand on Post-Crisis Reforms?

In the same week that we recorded a year of post crisis bull market, a 2,200 page report on the Lehman Brothers debacle thwacks down on desks. The former is a reminder that governments pulled financial markets back from the brink and, somewhat controversially, created the monetary conditions for banks to quickly return to profit, despite bearing a large portion of the blame for the economic meltdown.

Not surprisingly, the recent joint poll by Responsible-Investor.com, the Network for Sustainable Financial Markets and AQ Research, showed more than 90% of investment professionals believe moral hazard has increased.

The Lehman report is a dead-weight memorandum of market folly that looks set to whip up yet more legal cases and send a chill wind through the audit profession. But what in the markets has fundamentally changed? Shockingly, the diagnosis is little, if anything. An estimated $11 trillion of global GDP wiped out according to best estimates, 200 million job losses, but no proper reform. For investors, a lost decade of returns, yet barely a peep from them about systemic issues.

No wonder customers lack confidence in those who should be looking after their interests. The life-support machine for the banks, as well as the economy – government intervention – has worked. The “patient” is rehabilitated, with assets recovering, but that is of little comfort to the millions who have suffered from this recession. Time then, it seems, to start right back on the narcotics.

OK, perhaps a little worthwhile lifestyle change here and there: some tougher corporate governance, some attention to excessive bonuses, rehashed talk about long-termism. But, as I’ve argued before, little action on the continuing toxic dangers of off-balance-sheet banking, the destructive nature of some derivatives, clarity in audits, elimination of conflicts of interests amongst credit rating and sell side research agencies. These are core to the protection of investor rights.

In addition, as Lord Turner, chairman of the UK Financial Services Authority, argued in a speech this week, politicians and regulators need to rethink the view that more lending, greater liquidity and bigger markets are always better, whilst looking at transaction taxes and higher capital charges to curb risky trading that does not stimulate real economic growth. Institutional investors need to be at the heart of these vital discussions too.

Reports from the US, and elsewhere, indicate the potential for patient credit crisis relapse: housing foreclosures remain at dangerous levels while governments take their feet off the monetary gas in a continuing febrile economic climate. Who can say with confidence that they trust all the asset valuations on banks’ books, or have full faith in credit lines and the ability of companies to currently refinance debt? In today’s complex financial world, it’s worth going back to basics. Institutional investors exist to invest their customers money over the long-term. The sustainability and proper functioning of financial markets as well as the greater economic well-being of the economy and society is at the heart of their mission and their fiduciary duty to their beneficiaries.

The inter-generational savings deal is vital to their political and economic viability. Hence, the traditional view that the essential role of the financial services sector is to facilitate the allocation of capital to economically productive uses. These are useful road markers most institutions can agree on to chart a way forward in markets that have become systematically predatory and socially unpopular. Institutional investors are large, influential players in the market. And markets are not neutral. Deregulation (aka “light touch regulation”) created the conditions for the many bubbles we have suffered, and for moral hazard. Better regulation, based on sustainable, long-term goals can lead to more stable, prosperous economies. Today, we have the unacceptable inertia of widespread agreement on the need for substantial financial market reform countered by a handwringing consensus that banks will use their political influence to block, delay and water any changes down.

The collective muscle of institutional investors could be the dynamic that tips the balance in favour of the public good. More strategic collaboration between institutions, with a strong emphasis on educating clients and lobbying decision-makers – the latter won’t work without the former – is needed.

Once this intent develops, the finer, more complicated points can then at least be fully debated. A few thought leaders in the field understand this. But real impact, I believe, requires a behavioural change for organisations like the United Nations Principles for Responsible Investment (UNPRI) and the International Corporate Governance Network (ICGN), from whom we’ve heard little or nothing through this crisis. Responsible investment and better corporate governance are weakened concepts if the broader financial system is unsustainable.

If investor responsibility can’t grapple with the big issues, what is the point of these organisations? We need them to step up to the plate. The US has taken something of a lead in this regard with the appointment of an Investor Advisory Committee to the Securities and Exchange Commission (SEC). It has a mandate to represent the viewpoints of investors for recommendations to the Commission. US investors should work hard to ensure its voice is heard. And the Volcker Plan – even if it doesn’t go far enough – is a good example of real action.

Elsewhere, we need more joint effort of this type to examine where regulation needs influencing, vested interests loosening and systemic blockages unplugging. Sceptics who argue that this is something institutional investors can’t or won’t do need only look at the recent furore over the EU Alternative Investment Fund Managers Directive to witness the power of collective lobbying. That saw institutional investors stand up alongside private equity and hedge fund lobbyists to target governments, leading to this week’s Directive postponement. Whatever the merits of that campaign, I would argue that the future sustainability of the financial system merits an equal, if not greater, mutual response.

I won't get into a whole discussion on what I think pension funds should be doing to bolster corporate governance. At a minimum, they should stop allowing Wall Street firms to continue paying ungodly bonuses even if they lose billions of dollars. That's just insane.

Also, watch the interview below with FT Alphaville reporter Stacy-Marie Ishmael on why without meaningful reforms, investors will inevitably get burned again on OTC derivatives. Ishmael thinks there should be a "rethink of suitability" when it comes to derivatives as well as "higher standards of disclosure."

Anyways, I am tired tonight, having just come back from Rosalie restaurant where I had dinner to raise money for WaterCan, a Canadian charity dedicated to fighting global poverty by helping the world’s poorest people gain access to clean water, basic sanitation and hygiene education. I had a great time, and thank the people from Aveda Montreal for organizing a wonderful evening.

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I am an independent senior economist and pension and investment analyst with years of experience working on the buy and sell-side. I have researched and invested in traditional and alternative asset classes at two of the largest public pension funds in Canada, the Caisse de dépôt et placement du Québec (Caisse) and the Public Sector Pension Investment Board (PSP Investments). I've also consulted the Treasury Board Secretariat of Canada on the governance of the Federal Public Service Pension Plan (2007) and been invited to speak at the Standing Committee on Finance (2009) and the Senate Standing Committee on Banking, Commerce and Trade (2010) to discuss Canada's pension system. You can follow my blog posts on your Bloomberg terminal and track me on Twitter (@PensionPulse) where I post many links to pension and investment articles as well as my market thoughts and other articles of interest.

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